Unless you were born into wealth, you may have daydreamed about what you would do if someone left you a large sum of money. Maybe you pictured yourself driving an expensive sports car, being pampered at the best hotels – that sort of thing. Imagining a financial windfall makes for nice fantasies, but what should you do if one lands on your doorstep in real life?
That’s not as far-fetched as it may sound. If your parents have acquired significant assets, you may inherit a substantial sum when they are gone. If you have built a successful business or professional practice, you will probably decide to sell it at some point, creating your own “windfall.” If you are a founder or early employee of a start-up gaining traction and attention, being acquired could generate a big cash payout.
You may think, “a financial windfall would be a good problem to have,” and that’s true! But, if you come into a large sum of money all at once, you have some decisions to make. What you do with that money could make your life not only more financially secure, but also more rewarding than you might have imagined was possible, or you could fritter it away and end up with a pile of regrets.
What qualifies as a “windfall”?
There is no definition or threshold for what constitutes a financial windfall. For someone who lives hand-to-mouth and juggles credit card debt, a gift of $10,000 could qualify. To someone who makes $250,000 a year, that same $10,000 would be nice but probably wouldn’t be seen as a “windfall.” If your net worth is $10 million, that $10,000 would be just 1/10th of 1% of your wealth. So, what qualifies as a financial windfall depends on the life circumstances of the person who receives it.
Does a windfall change your life?
If you expect to receive a large amount of money soon, it is helpful to ask yourself the following: Does this amount of money have the potential to change my life? Let that sink in for a bit.
What could “change your life” mean? That depends on where you are in terms of your overall financial picture and what you want/value in life. In other words, changing your life doesn’t necessarily mean moving to a more expensive neighborhood. A better way to think about whether a windfall is enough to change your life is to think about the financial and emotional freedom it could create.
Imagine a large financial windfall, enough to pay off your mortgage and other debts and maybe fund college educations for your children or grandchildren—if that is a goal. If you were debt-free, including owning a house with no mortgage, you would have much more discretionary income for other things. You would also relieve or eliminate the stress of debt – that’s freedom.
You probably wouldn’t need to maintain your current income level to cover your lifestyle, fund your retirement, and meet other financial goals. That gives you the freedom to consider changing your career path, to do something that would pay less but bring you greater personal satisfaction. That could mean teaching, running a catering business, or maybe opening a neighborhood bookstore. That could be truly life-changing.
Financial Windfalls and Your Risk Tolerance
You might expect people who experience a financial windfall to take more risks – after all, they have more money in the bank now. But in our experience, the opposite tends to happen. People are often concerned about protecting the money they receive from a windfall and, therefore, often become more risk-averse, at least in how they invest.
One’s attitude toward taking risks with a financial windfall can differ depending upon the source of the money. If you built a business by investing time and effort into it over the years, it undoubtedly involved sacrifices, such as missing out on time with your kids. So, when you sell the business, you might feel strongly about protecting the money you receive from the sale—after all, it represents the “sweat equity” you poured into your company.
In contrast, if you receive a sizable inheritance, you may believe the person who left you the money would have wanted you to use it to enjoy life. In that case, you may decide to “live it up” – maybe buy a sports car or a ski condo instead of boosting your retirement savings.
Of course, we could turn these perspectives upside-down. A business owner who cashes out may say, “This is what I worked so hard to accomplish – I’m going to enjoy spending it now.” And, if your parents left you a portfolio of stocks they had owned for decades, you may feel emotionally conflicted by simply thinking of selling any of them, even if doing so would allow you to pay off your mortgage and remodel the kitchen.
Reacting Emotionally Versus Financial Planning
Questions about whether to invest or spend a windfall and how to invest or where to spend it, all lead back to the same answer: if you have a solid financial plan, one that reflects your goals and priorities, it all falls into place because you follow your plan.
A financial plan specifies what to do with the financial resources you have. A windfall simply increases your resources and accelerates the timetable. Before selling a business or inheriting money, let's imagine that your plan states that you will use your income to pay down your mortgage every month, fund your children’s 529 Plans up to $X, and set aside $Y for retirement. After accomplishing those things, the plan says you will use your discretionary income – now increased because you have no mortgage and other financial goals have been met – to go on an African safari, your top “wish list” item.
There’s your answer. First, you use the financial windfall to pay off your mortgage and fund the 529 Plans. Depending upon how much is left, add to your retirement savings and start planning that trip to Africa. If you have a solid financial plan in place, you already know how to use the money from a windfall. Of course, you may want to take a small percentage of the total and “splurge” on something, but that’s something to work into the plan.
Working with a financial advisor is particularly useful because a thoughtful financial plan provides guidance and peace of mind. It becomes much easier to be confident about how to use a financial windfall when you are following a plan instead of just “winging it.”
Financial Windfall Missteps
Here are three mistakes we’ve seen people make with financial windfalls.
Lifestyle creep. A common byproduct of a financial windfall, this begins with the thought, “I have money now,” and leads to unsustainable new spending habits (a new car every two years, eating out instead of at home, expensive vacations, etc.). This ends up making your long-term goals harder to achieve. Having a solid financial plan helps you to avoid this trap. A good financial advisor can point out problem spending that may derail your plan.
Clinging to inherited assets. The old saying, “what you own owns you,” is particularly relevant when you inherit assets because those assets become your responsibility. It takes time and effort to manage an investment portfolio, even more with real estate. If you inherit your parent’s home and feel reluctant to sell it, know that becoming a landlord can make you less free, probably not what your parents would have wanted. You are also dealing with grief, so it’s important to carefully consider what makes sense for you and your family if you think it would be dishonoring your parents’ memory to sell something they valued.
Overlooking taxes. Of course, whether your windfall comes from selling a business or an inheritance, there are tax considerations that could lead to unintentional, costly errors. For example, it may make sense to sell stock you inherit immediately to avoid capital gains taxes. Business owners should meet with a financial advisor and tax expert when they consider selling the business. If charitable giving is part of your financial plan, you’ll want to do that in a tax-aware way.
A financial windfall can open new doors and could be life-changing. If good fortune or your efforts result in a big windfall for you, there will be much to think about and much to be grateful for. Having a thoughtful financial plan before it happens will guide you toward the freedom your windfall can represent and provide peace of mind that makes it all much more enjoyable.
Disclosure: Advisory Services are offered through Gold Medal Waters, a Registered Investment Advisor. This post and material presented are for informational and illustrative purposes only, and do not constitute investment advice and is not intended as an endorsement of any specific investment. As such, this material is not client-specific, we make adjustments in individual portfolios based on each client's financial plan, income needs, risk tolerance and total asset allocation. Interactive checklists are made available to you as self-help tools for your independent use and are not intended to provide investment advice. While Gold Medal Waters believes information derived from third-party sources to be accurate and reliable, we do not claim or have responsibility for its completeness, accuracy, or reliability in regard to your individual circumstances. Investors should carefully consider the investment objectives, risks, charges, and expenses associated with any investment. The information discussed is not intended to render tax or legal advice. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Investing involves risk including the potential loss of principal, and unless otherwise stated, are not guaranteed. Past performance does not guarantee future results. No investment strategy can guarantee a profit or protect against loss in periods of declining values. Consult your financial professional before making any investment decision.
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